Mutual funds: Vanguard's moves good for shareholders, again

Chuck Jaffe

If you're a fan of Vanguard funds, two announcements the company made last week should have come as good news.

If you're not a Vanguard investor, those same events might make you wonder if you ought to be, because chances are your fund company is not treating its shareholders quite as well.

The news was hardly earth shattering, but the world's largest fund company on Wednesday issued two separate statements. First, the company made its low-cost Admiral shares more widely available, eliminating some confusion in the process by phasing out Signal shares. Then, the company announced plans to merge five funds out of existence, in a move that reduces redundancy and shareholder confusion, while making investment choices more clear for shareholders.

The real news, however, is buried in the details, and if Vanguard can set an example for the rest of the industry (and it typically does), that means investors from all fund companies should be paying attention.

To see why, let's break down the news, starting with the improved access to Admiral shares.

Functionally, for each of its funds, Vanguard runs one pool of assets, and then applies a different pricing structure to each. Thus, the Investor Shares class for, say, Vanguard Total Stock Market fund (VTSMX) charge 0.17 percent in annual fees and requires a $3,000 minimum, compared to the Admiral class (VTSAX) where the minimum of $10,000 brings reduced expenses of 0.05 percent. The Signal shares version of the fund (VTSSX) has no minimum and the 0.05% fee, but is sold only through advisers; investors can also buy the index through an exchange-traded fund (VTI), with no minimum purchase requirement and the 0.05 percent expense ratio, but where an investor faces commissions on trades.

Vanguard is eliminating Signal shares, which were not available on all of the firm's offerings, and eliminating the Admiral shares' minimums for institutional investors and retail clients working through financial advisers.

By eliminating the minimum for advisory clients, Vanguard made its funds more competitive with the ETF share classes; investors will have to decide if they prefer the ability to trade minute-by-minute over the savings from having no commissions. (My advice, save the money and buy the fund.)

That said, the move is more proof that ETFs are not just taking market share from traditional funds, they are also pushing operating costs down; you should be looking for similar cost savings from other fund firms (and looking to make a change if you invest with a firm that refuses to keep up).

Meanwhile, the fund mergers clean up the Vanguard line-up, and most fund companies should take a similarly critical look at their line-up and jettison the superfluous, redundant, the mis-labeled, the bad ideas and the lousy; if the fund world was a meritocracy, about half of all issues would close tomorrow.

Two of Vanguard's merger moves - all closing overt the next few months - involved issues tracking the same index. Vanguard Tax-Managed Growth and Income will be folded into the Vanguard 500 Index fund, both tracking the Standard & Poor's 500, and Vanguard Developed Markets Index will absorb the firm's Tax-Managed International fund, both tracking the FTSE Developed ex North America index.

The selling point on the tax-managed issues was that they wouldn't pay out capital gains, and they achieved that goal. But so did the funds that were not "tax-managed;" for proof, consider that the 500 Index fund hasn't paid out capital gains in over a decade.

The merger of Vanguard Growth Equity into U.S. Growth is the company getting rid of one of its lagging track records and propping up another fund that was a long-time laggard until management changes got performance to start looking up over the last few years. While closing both funds might have been a better move for shareholders, U.S. Growth remains a popular option in retirement plans and those long-term shareholders clearly have not been pining for a change.

Lastly, Vanguard changed the structure of its Managed Payout funds, an interesting concept that has had limited success. The Independent Adviser for Vanguard Investors noted several months ago that this suite of funds, each built to have a specific payout and a constant distribution rate, wasn't living up to its sales literature.

The three issues, with a combined $1.45 billion in assets, will all be part of the re-named Vanguard Managed Payout fund, which will have an annual distribution target rate of 4 percent. That's a full point below the level promised by the existing Managed Payout Growth and Distribution fund, but it's much more manageable.

That doesn't mean the combined fund will do a better job than the existing models, but it has re-shaped expectations, which should at the least make results less disappointing.

Fund companies that are willing to collect their management fees while performance is lackluster or their concept flawed are the norm for the industry. Trying to work out problems, which alerts shareholders to the issues, is something fund firms should do more of; it doesn't guarantee improvement, but it shows concern and effort in an industry where those qualities can be hard to find.